The world of high finance is full of wonderful instruments and structures. To put them to use is called 'financial engineering'. I have always wondered why, so far, non of Greece's debt has been 'financially engineered'. However, progress is under way and now the media have found a new expression of the year: Perpetual Bonds! And what, exactly, are perpetual bonds? I will try to explain in layman's terms.
A Perpetual Bond is also referred to as an Evergreen Bond. To sum it up: those bonds must NEVER be repaid, not in full and not in part, as long as the terms of the bonds are complied with. The most important such term is the payment of interest.
A Perpetual Bond is, in essence, a play on interest payments. Since the principal never gets repaid, there is no need to worry about the repayment of principal. The only worry is to be had about receiving interest payments on time.
Suppose the bond is for 100 units and the interest rate is 5% p.a. That means the borrower has to pay 5 units in interest every year. Suppose the borrower is viewed as troubled and people worry that they might not receive the next interest payment. So they won't pay 100 when they buy the bond but perhaps only 50. If they can buy it for 50 and the next interest payment is made on time (5 units), their return is all of a sudden 10% and no longer just 5%. Nota bene: this process works exactly the same way in reverse!
A Perpetual Bond is a wonderful substitute for a rating agency. When prospects are positive and the next interest payment is very likely, the bonds will rise in value. When prospects go South, the bonds will fall in value. Look at the price development of the bonds and you will know how the market rates the borrower.
A Perpetual Bond is also referred to as an Evergreen Bond. To sum it up: those bonds must NEVER be repaid, not in full and not in part, as long as the terms of the bonds are complied with. The most important such term is the payment of interest.
A Perpetual Bond is, in essence, a play on interest payments. Since the principal never gets repaid, there is no need to worry about the repayment of principal. The only worry is to be had about receiving interest payments on time.
Suppose the bond is for 100 units and the interest rate is 5% p.a. That means the borrower has to pay 5 units in interest every year. Suppose the borrower is viewed as troubled and people worry that they might not receive the next interest payment. So they won't pay 100 when they buy the bond but perhaps only 50. If they can buy it for 50 and the next interest payment is made on time (5 units), their return is all of a sudden 10% and no longer just 5%. Nota bene: this process works exactly the same way in reverse!
A Perpetual Bond is a wonderful substitute for a rating agency. When prospects are positive and the next interest payment is very likely, the bonds will rise in value. When prospects go South, the bonds will fall in value. Look at the price development of the bonds and you will know how the market rates the borrower.
Mr. Kastner,
ReplyDeleteThank you for the easily understandable explanation. Now, we shall see what Don Vito will reject from this offer. Usually, when Don Vito offers nothing and he gets from a weaker part a counterproposal, he will reject most of it. Don't you think?
Berlin has every reason to drag this for months, hoping to "starve out" Greece. Tsipras on his side, has every reason to continue his efforts to rally the people and increase his popularity, so that if June comes, he can either use it for referendum or for defaulting.
In my analogy, Don Corleone has to be on the Greek side!
DeleteI see. I can't picture Don Vito as the greek, because nowhere in the Godfather, does one have the impression that Don Vito is in inferior position. Tsipras, is essentially without allies inside the EU. his banks' liquidity is under threat and reliant to the creditors. I can't see him as being in the chair of Don Vito.
DeleteI expect Mrs. Merkel to "teach him a lesson" soon. I don't think this is prof. Varoufakis final offer either.
Excuse me: what is the offer? All I know is that the FM threw an idea at a hundred of so financiers in London and later talked about it with the FT. This is no way to run a railroad!
DeleteThe only Don Corleone I have seen on the Greek side so far is Mr. Dragasakis.
Mr. Kastner,
DeleteDo you think that the visits to various european capitals are just courteusy visits and that they expect to hear from the television like the rest of us? He is preparing ground and already we, outsiders, know more details. I would wait for when the circle will close, with the final visit in Berlin.
Ah, something else. Prof. Varoufakis, in positioning. The fact that after his visits, his creditor meet, indicates that they have things to talk. The offer will be finalized on paper, but the main points have been drafted.
DeleteWhen watching the Godfather, did you feel that Don Vito Corleone was a small mafia boss, going against multiple clans, from which he largely depended with his only card his self-destruction?
@ Anonymous at 9.51
DeleteEverybody has his own style and strategy. My style and strategy would have been different. I would not have spent so much (air) time trying to mobilize weak allies against a strong opponent because it would have reminded me of President Johnson: "when the fleas are starting to itch the elephant's trunk, they might get whacked, whacked good".
I would have followed the motto "when in Rome, do as the Romans do". Before you can ever get significant financial support from someone, you have got to obtain his trust. Seldom has so much trust been destroyed within only one week. Correction! Enormous trust and even admiration has been built up with Keynesians. But all those leaders who are not Keynesians (and certainly the German leaders are not!) must now be wondering how they can ever trust people who switch from threats to declared friendship frequently, sometimes even within the same interview.
Mr. Kastner,
DeleteA reply to you. I think that your strategy, is a reasonable one, in a neutral enviroment and amongst neutral players. Where i can object, is exactly the enviroment and the players (being greek is automatically a deficit for trust). Europe's center of power is Berlin. Berlin, had openly campaigned against Tsipras not so long ago. Tsipras' program, rhetoric for 4 years, was against anything Germany ever tried to impose on the greek program. Tsipras' rhetoric was against Mrs. Merkel and Mr. Schauble, both mentioned explicitly. I am greek and i can't trust SYRIZA's program. Current SYRIZA MP and economics professor Mr. Costas Lapavitsas,just on Dec 29 was writing: "Syriza's program is reasonable, but lacks 20 beur":
http://www.protothema.gr/politics/article/438447/lapavitsas-to-programma-tou-suriza-einai-logiko-alla-tou-leipoun-20-dis-euro/
On what ground would anyone in Berlin have any trust on Tsipras? On the ground that he wanted to tear down all the troika program, which in essense was Germany's program? On the ground of promices of virtue? I have heard many things about Germans. Taking promices over facts, isn't one of them.
Let's go to Keynesians! I can't ever recall Renzi being full of trust or admiration for Tsipras! Hollande has been lost in his world and it took a terrorist attack to bring him a glimpse of popularity. Renzi is afraid of Tsipras. Because should Tsipras have free hand with his plan, Renzi would be accused for being "a false socialdemocrat" (he already is!) and people would say "are you a man of the left or just a new Monti wearing new suit? The Irish initially had a minister come out to publically support Tsipras' idea for debt convention, soon after Kenny took everything back, thinking "why walk amongst the buffalos, if Tsipras gets something, i can always come later and ask". The Keynsians Mr. Kastner, want to use Tsipras, as a means to relax the fiscal rules, have investments. They never really cared about the rest of the core Tsipras' demands.
Trust is BUILT, not donated. And Tsipras hasn't done anything in the last 4 years, as far as i recall, to have built any trust. He was simply sounding pleasing to some economists or journalists, because, as with most people, they seek self-approval and they like to read the echo of their thoughts. So for Keynsians, a Tsipras "against austerity" is pleasant. But, who is the european leader that was ever Tsipras' big admirer, in a way that he is ready to let him do his "national plan" and on top, give him a debt restructuring (or was it the "haircut of at least 50% that was making them admire him?!). It isn't even primarily about trust, as it is about interests. Have you ever heard any Keynsian politician in Europe come out before the greek elections (where there was no trust issue), to say "we need to give debt relief to Greece like Tsipras says?".
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DeleteMr. Kastner, Tsipras' "national plan" is destined to stumble on Germany's idea of "greek plan". Or as i had written before, on the definition of "reform". Tsipras, in his haste to grab power, forgot to secure his best ally (Podemos in Spain). Now he finds himself with many pats on the back and a choice that whichever road he takes, he will have to disappoint some of his voters. The only admiration Tsipras had, was in the press and in some academic circles. Renzi wants Tsipras for more laxity in the rules. Hollande, the same. In Spain they fear him, that if he succeeds, Podemos will grow stonger. So, who are the admirers? Martin Schultz? Those who matter, are those in the goverments. In Podemos' eyes, Tsipras may be Che Guevarra. In De Guintos' eyes, he is a threat. Prof. Krugman was his admirer? Does he have a chair in the Eurogroup or the ECOFIN?
I would have followed the motto "there is state continuity". I would have said that i can't tear down measures already taken by the previous goverment and that i want to agree on a new plan, which i will submit to the people for referendum. I would have also waited for Podemos to come in power in Spain, but Tsipras is too avid for that.
Ruling a country is so easy when in opposition. It is like military drills on a drawing board. You always win! Tsipras' best ally, is ironically, Obama. Now, if he let's Tsipras alone, well... I believe he will get a package, but not the one he promiced his voters. Che Guevarra became a legend, because he failed. Because he died. Tsipras unfortunately, will have to actually rule.
"A Perpetual Bond is a wonderful substitute for a rating agency." Congratulations. One of the most brilliant policy ideas I have ever come across. For countries big enough to have a bond issue big enough to make it difficult to manipulate it is just about perfect. It seems that as long as we discuss banking, finance and similar we can agree and have good ideas. It is when we discuss politics, geopolitics and history that we cannot agree on much.
ReplyDeleteDear Mr. Kastner,
ReplyDeletePlease try to make a better projected example if a debtor is going well and if a debtor is going bad scenario.
Basically, you pay only interest at a fluctuating rate and the interest fluctuates based on if you pay back. Is it something like a personal loan pegged to the european interest? or is the interest payment based on your performance?
It really sounds like a great financial tool. Hell if i was varoufakis i would ask fro 100 billion perpectual bond find a partner to build the port of peiraus with, fix the infrasturcture of the trains as to focus on becoming the server of europe for goods coming from asia. The next perpectual bond 100B I would fix all the the touristic ports and airports of Greece, subcontract the managment of these stations to the private sector. Then Invest and subcontract the natural gas under crete. Then tap it off with the biggest solar and wind energy project the world can see. :-)
Then the proceeds pay for the boind interests and make greece a tax free country. :-)
How is that for a growth plan? :-)
V